November 17, 2014

What causes asset price bubbles? The paper below (just released) by Sheen Levine and David Stark looks into the issue in an original way. Findings: ethnic homogeneity promotes conformity and leads to misplacing; diversity disrupts conformity and leads to better information processing.

Here’s the longer summary:

In this paper from the Proceedings of the National Academy of Sciences, Sheen Levine and I (together with other co-authors) examine a prominent market failure: price bubbles. We propose that bubbles are affected by ethnic homogeneity in the market and can be thwarted by diversity. Using experimental markets in Southeast Asia and North America, we find that market prices fit true values 58% better in ethnically diverse markets. In homogenous markets, overpricing is higher and traders’ errors are more correlated than in diverse markets. The findings suggest that homogeneity promotes conformity. Price bubbles arise not only from individual errors or financial conditions, but also from the social context of decision making. Informing public discussion, our findings suggest that ethnic diversity disrupts conformity and leads to better information processing.

October 2, 2014

There are three things wrong. The first is that risk management has become too bureaucratic. It emphasises a controls-based approach, characterised by excessive box-ticking. The second is in the financial arena, where banks and other financial institutions became reliant on value-at-risk models. Those models were dependent on a range of assumptions, not least an implicit assumption about liquidity and the real availability of interbank funding.

In hindsight, we can see there was insensitivity to the limitations of those models. And the third thing to go horribly wrong was focusing on entities in isolation, rather than the relationship between entities. Banks and insurers all used the same risk management model. But they didn’t consider what would happen if they all acted in the same way and how that would create a systemic problem.

September 19, 2014

In this issue of the London Review of Books, Donald Mackenzie describes the communication technologies that help high frequency traders do their thing (Be Grateful for Drizzle, v. 36:17). After an extensive discussion of how fibre-optic cables, microwaves, millimetre waves, and laser transmission through the atmosphere move information between the exchanges, Mackenzie asks a relatively straightforward question:

The right question to ask about high-frequency trading is not just whether high-frequency traders are good or bad, or whether they add liquidity to the markets or increase volatility in them, but whether the entire financial system of which they are part is doing what we want it to do.

Compare and contrast to Vasant Dhar, former HFT trader and Head of Information Systems at Stern School who wrote in a commentary at CNBC:

Let’s not risk our markets to a populist-based reaction that asks whether HFTs do any “social good,” but rely instead on an objective analysis of the “big data” that emanates from the markets.

Ugh.

I’m torn.

On the one hand science studies says that technologies can be designed to accommodate a variety social visions. On the other, once in place, material infrastructures do constrain the kinds of choices we can make.

I definitely think we have to treat big data analyticsasa space where political battles can happen in data-saturated systems, but it can’t be the only one. And yet, the dominance of digital data must neutralize some of the tools that social scientists usually deploy to contribute to the conversation. Not all conversations about the social good are possible, but which ones are…?

Since exchanges are not my topic of research, I’m sort of off the hook on this one. But still, I’m left wondering how to go about taking a position.

Masters in Finance, Markets and Organizations – University of Leicester School of Management

The course will give you tools to perform organizational and technological analysis of financial markets' behavior, in addition to conventional financial analysis. The program teaches a unique analytical approach that combines finance and accounting knowledge of financial markets with insights from management and sociology. The degree program in Finance, Markets and Organizations is building on research experience and teaching experience from the University of Edinburgh, London School of Economics (LSE) and the University of Chicago.